KPMG: A Contracts Cornucopia

A few weeks ago, Judge Kaplan of the SDNY denied KPMG’s motion to dismiss the KPMG defendants’ complaint against it for indemnification of the defendants’ legal fees. (Seecoverage at TaxProf, and for background, my previous post.)

The opinion is really fascinating. Although I disagree with parts of Judge Kaplan’s analysis, I think it will ultimately come to be seen as a paradigmatic modern contract case, and classic casebook fodder.

I’ll assume your background with the underlying facts, and jump right back in where we left off. Why is the opinion worth casebooking?

1. KPMG claimed that the indemnification dispute was arbitrable. Factual disputes abounded (some defendants had distinct contract language, and the firm had apparently done a relatively weak job at capturing “Separated Members” in new arbitration agreements). But “in any case,” Judge Kaplan found the arbitration agreements void as against public policy. This was no surprise, because he wrote just three months ago that “Assuming that . . . KPMG remains insistent upon its alleged arbitration remedy, the questions whether the arbitration clause properly is so construed and, if so, whether it is void as against public policy [as frustrating the court’s decision] will be addressed . . . .”

Now I usually tell my students that arbitration is favored by courts and that public policy arguments are weak ones. Not here. The Court found several factors weighed against the arbitration clauses’ enforceability: (1) the public’s right to a speedy trial; (2) the right to a fair trial, with “counsel of his or her choice” and “the funds lawfully available to each” to effectuate that choice; (3) the fact that if the Court didn’t advance these costs from KPMG, it might have to dismiss the indictment altogether; (4) the public’s burden in paying for these defendants’ defense were they to become indigent (not the Judge’s best argument); and (5) the public determination of an issue intimately connected with a public criminal trial. Judge Kaplan found that the arbitration agreement itself “affords an opportunity for delay, and KPMG obviously has no interest in having the advancement dispute decided quickly.” (Slip. Op. at 32). That “purely private interest” was “decisively outweighed” by the defendants’ constitutional rights and the public interest in avoiding dismissal of the indictment.

This is a very odd holding, on a few levels. Fundamentally, it runs counter to the great weight of authority, which burnishes arbitration as the best way to save judicial resources, a paragon of efficiency. Unlike, say, the now-common claim that arbitration clauses ought not to be enforced when not bargained for, Judge Kaplan’s criticism that arbitration causes delay and is private justice would seem to sweep rather far. (Notwithstanding his disclaimer on p. 39.) It surely is true that KPMG will be incented to delay an arbitration. But, if that were true, why not reform the agreement and require the arbitrators to rule promptly. That would effectuate both parties’ intent (not, as Judge Kaplan states, merely KPMG’s) in securing a private forum for personal disputes of this kind.

2. Judge Kaplan’s alternative footnote argument from his first opinion turned out to the theory of the case here: an implied in fact contract to advance fees. On the motion to dismiss, as Judge Kaplan noted, it would seem to be a tough claim for KPMG to fight, because a contract implied in fact “may result as an inference from the facts and circumstances . . .” (Slip. Op. at 42). KPMG nevertheless claimed that it never intended to provide a contract to its employees. Nuts to them, the Judge responded, following a basic tenet of contract law that I’ll be teaching Wednesday: “the formation of contracts is based on the parties’ objective manifestations of assent, not their uncommunicated subjective views.” (Slip. Op. at 42.) True. But this argument is somewhat in tension with Judge Kaplan’s later argument that the issues here are simple to resolve and will require little discovery. By contrast, I’d imagine that KPMG would want wide ranging discovery focusing on industry practice, and the employees would want to depose HR folks who likely left the firm years ago. Implied in fact contracts, unlike ordinary contracts, are really messy to litigate. Which is why KPMG tried to resort to its merger clause (which I’ll teach in a few weeks – I tell ya, this opinion’s chock full of issues). But the opinion holds that the merger clause didn’t cover the subject of advancement. Which leads to a practice point: draft merger clauses as broadly as possible.

3. KPMG claimed a failure of consideration and mutual assent: but the opinion dismisses the arguments in a footnote, holding that the defendants might have agreed to work in return for the indemnification claims. More evidence, for those who are counting, that consideration rarely matters in real life.

4. There is an Erie issue: the FRCP arguably prohibit the type of speedy civil hearing that Judge Kaplan has determined that the advancement claims merit, but the Rules conflict with state substantive law. The opinion holds that the “rules governing the issues properly considered in determining a claim for advancement of defense costs are matters of substance, not procedure . . .” (Slip. Op. at 62.) I found this discussion confusing, in part because I don’t see how the right to advancement is (in effect) the type protected by specific performance instead of ex post money damages. But I’m not an Erie expert. Is there an Erie expert in the house?

5. The opinion makes fun of the distinction between “published” and “unpublished” district court opinions: “[t]he Court would pass such a contention without comment save for the fact that KPMG’s memorandum cites eight cases that are ‘unpublished’ in the same sense as well as one that does not appear even in the computer assisted legal research services.” Slip. Op. at 15 n.36. Whoops!

Looking at PACER, it seems as though the case is now on appeal, presumably because denials of agreements to arbitrate are subject to interlocutory review under the FAA. Can it really be that the trip up to the Second Circuit (and possibly beyond) will be shorter than the arbitration process?

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Dave Hoffman

Dave Hoffman is the Murray Shusterman Professor of Transactional and Business Law at Temple Law School. He specializes in law and psychology, contracts, and quantitative analysis of civil procedure. He currently teaches contracts, civil procedure, corporations, and law and economics.

Good comment, Dylan. My pet peeve: a court saying arb is a “favored provision.” What does that mean? That if the contract doesn’t call for it, we’ll add it anyway? That if the contract does call for it, we’ll make it doubly required? That once the two sides articulate competing theories of interpretation we’ll stop applying critical thought and toss everything off to arb-land?

What would be so wrong with “arb clauses are like other contract clauses: if you add them we’ll enforce them, if you don’t we won’t, and if it’s initially not clear we’ll apply the same construction techniques we do for other clause”?